Single Member S Corp: Everything You Need to Know
A single-member S Corp is a single-member LLC that has chosen to be treated as an S Corporation for tax purposes. 3 min read
A single-member S Corp is a single-member LLC that has chosen to be treated as an S Corporation for tax purposes.
Electing S Corporation Tax Status for a Single-Member LLC
A single-member LLC is automatically considered a disregarded entity for federal tax purposes. However, it is also possible for you to choose to be treated as an S Corporation or C Corporation if you are the owner of a single-member LLC. An S Corp is a small company that is closely held.
Because they are pass-through entities, S Corporations are very similar to sole proprietorships and standard limited liability companies. A pass-through entity is a business where income is passed personally to the business owner so that it can be reported on the individual tax return. If you're interested in being treated as an S Corp, you will need to fill out and submit Form 2553 with the IRS.
After you've established your single-member LLC, you can elect to be treated as an S Corp any time you wish. There are certain limitations, however. For instance, your status as an S Corporation must be effective:
- Within 75 days of filing the IRS form
- Within 12months after your form was filed
Both S Corporations and single-member LLCs can be taxed as pass-through entities. One of the biggest differences is that S Corps require considerably more paperwork. The main reason you would choose S Corp status is to lower your self-employment taxes while still having the benefits of pass-through taxation.
When your single-member LLC is considered an S Corporation for tax purposes, you no longer count as being self-employed, meaning you will not have to pay the self-employment tax. Instead of being self-employed, you are considered a company employee. You will also be able to use company profits to pay yourself a salary. However, you may not have access to all available company profits.
Any additional profits earned by your single-member LLC can be withdrawn as dividends, which would prevent them from being double taxed or being subject to employment taxes.
When your single-member LLC is treated as a disregarded entity, the self-employment tax applies to all your company's profits.
Essentially, gaining S Corp status allows you to avoid paying employment taxes on dividends from your company. This leads many people to believe that they should take all of their single-member LLC money as dividends so that they can completely avoid self-employment taxes. Unfortunately, this practice is prohibited. You are required by the IRS to pay yourself a reasonable compensation. Applying for S Corp status for the sole purpose of avoiding self-employment taxes is not the best idea for a number of reasons.
If you're serious about being treated as an S Corp, however, you should consult with an experienced attorney and tax professional to make sure that you have organized your LLC correctly, that your company is following all IRS rules, and that S Corp status would substantially benefit your LLC.
Many single-member LLC owners find it hard to determine what counts as reasonable compensation, as there have been court cases that have listed as many as nine factors for determining this issue. The IRS has a list of ten factors that can be used to determine reasonable compensation. Typically, accountants use a 60/40 rule where 60% of profit is taken as salary and 40% as dividends. Another way to determine reasonable compensation is researching companies similar to your own with the U.S. Bureau of Labor Statistics.
As an example, let's say that you formed a business ten years ago as a single-member LLC. Six years after your LLC was formed you decide to apply for S Corp status. In the previous year, we'll assume that your business was very successful and earned a net profit of $100,000. After doing the proper research, you discover that the typical salary for someone in your file is between $50,000 and $60,000. By paying yourself a salary of $60,000, ensuring you've paid your Medicare and Social Security taxes, and taking the leftover $40,000 profit in dividends, you should not have to pay any employment taxes, thanks to your S Corp status.
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